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Do Diligence | By: Multiple Speaker(s)

Do Diligence
By Vena Jones-Cox

Between seller calls, MLS leads, and bulk packages, my office deals with somewhere in the vicinity of 20-30 property leads each week. And since the majority of the time invested in evaluating a property is in the process of driving to, looking at, and creating a repair cost estimate for it, we’ve discovered that it’s a big time-saver to know as much as possible about whether that property is a likely deal BEFORE anyone wastes 2 hours looking at it.

That’s why we have a “pre-inspection” due diligence system for leads that’s run BEFORE we spend time on the time-consuming part. This week, I thought I’d share that system with you.

If possible, we want to know what the seller’s bottom dollar and terms are before we inspect. I say “if possible”, because this requires direct contact with the seller—something we don’t have when the property is listed and, in many cases, when we’re looking at a bulk package of properties.
However, when a seller calls us directly, we positively will not set an appointment to look at a property unless he’s told us that he’ll accept a price (or terms) that LOOK as if they might work. How do we know before examining the property that the price “might work”? Because, before we’ve seen the property, we’ve always done this:

Run comps on the property. Once you get a decent comping system (I recommend Haines Criss-Cross + Real Estate or RealQuest) and get good at using it, it takes less than 5 minutes to generate and evaluate comparable sales for any given property. We do this on ALL prospective deals, no matter what the source, to get a handle on:
What fixed-up properties are selling for (if there are any)
What distressed properties are selling for (roughly)
How many sales are happening in the area

Tried to determine the general condition of the property. Again, I say “tried to”, because we simply can’t get a lot of direct information from the seller about this. Out of town owners often tell us they’ve never set foot in the home; bulk sellers usually don’t know and don’t care what kind of shape their properties are in; agents don’t want to waste time on the phone describing the property condition, and even when they do, their information isn’t always reliable.
So when we’re talking directly to a seller who lives in or at least in the vicinity of the lead, we ask them, item by item, about the age and condition of the various components. When we can’t do this, we rely on other data:

Listing information from MLS. If the current listing says “needs TLC” and the last listing—from 2003—says “newer roof, kitchen, water heater, and furnace”, we know that we’re dealing with a 10 year old roof, kitchen, water heater, and furnace.
Permit and code violation information from the city. A simple call to the building department will tell us if any permits have been pulled for work on the property, and when; it will also tell us if the property has a barricade order or other code violations that would indicate poor or extremely poor condition.

Used the public record to determine who the owner is, what they paid, and when. This is true only when we have NOT been able to talk to the owner about his bottom dollar price, and when the owner is NOT a bank or a bulk seller. In other words, we use this search—which can usually be done on your county treasurer’s, auditor’s, or recorder’s site—to eliminate properties that are listed in MLS and owned by individuals.
We do this because, although sellers HAVE been known to sell a property for less than they paid for it—often, in fact—there’s a natural barrier to even the most desperate seller accepting an offer for significantly less than what he OWES on the property. Thus, if the auditor’s site shows that he paid $105,000 for his house in 2005, and got an FHA loan to buy it (meaning that he probably financed 101% of the purchase price), and I know based on comparable sales and my own formula for making offers that I am unlikely to want to pay more $45,000 for it today, I’m probably not going to bother to do see that property. Oh, and if it’s listed for significantly less than he owes, I know that the listing is either:

An undisclosed short sale or
An undisclosed REO—in other words, the foreclosure sale has already happened, and the bank is in possession of the deed, but has not recorded it
It’s worth a call to the agent to find out which of the above is the case. If it’s b), it’s worth taking a look at if it seems to be priced right for the same reason that ALL bank-owned properties are worth looking at if they’re priced right: it doesn’t matter what the prior owner paid for it or what the bank’s winning bid at the foreclosure sale was.

It’s actually a combination of the results of these steps that determine whether or not a particular lead is worth inspecting. I ran across a case this weekend that exemplifies the difference between a probable BFWOT (that’s Big Fat Waste of Time) and a possible deal. It went like this:

An out of town bulk seller called me with a tape of 9 properties for sale in my area. Bulk properties are notorious for being, with some exceptions, in terrible condition—so bad, in fact, that the offer that you come up with when you run through the ARV x .7 – repair costs formula is often a negative number.

But this was a “pick and choose” tape, which means that I can buy one, several, or all of them. Had it been a “take one, take all” package, I would have looked at each property, but under the circumstances, I wanted to inspect only the ones that looked like possible deals.

Property “A” was a 2 bedroom house in a purely rental area—there are no sales to homeowners in the neighborhood, and very few sales of properties that were not distressed at the time of the sale. Using the due diligence process above, I quickly discovered that:

The property had had a fire. Based on the orders against it, it was a fairly significant fire, requiring the roof and an addition to be torn off.
The property was subject to $6300 in back taxes—important, because most offers to bulk sellers are net to the seller; in other words, you are responsible for paying any back taxes.
This quickly left me with an understanding that:
The repair costs would be massive
The property is almost certainly not one that I could sell for even $6300
Thus I neither bothered to do any further due diligence nor inspect the house.

Property “B”, on the other hand, is a 5 bedroom house in a similar, mostly-rental area. In about 10 minutes, I found out that:

Based on an MLS listing from 3 years ago, it had new replacement windows
Distressed properties in the area (again, there are no sales of fixed-up properties) are selling for $5,000-$11,000
There are no building orders against the property
The seller paid $789 for the house
The back taxes are only $158
So I DID look at this house, because a rough guesstimate tells me that I could sell this house to another investor for roughly $7,000 and my research tells me that the seller CAN sell for much less than that—although whether or not it will remains to be seen.

Doing this pre-inspection due diligence won’t always keep you from being dragged into a BFWOT; sometimes there are no city orders on a property because it’s already been torn down, and what you and your seller thought was a 3 bedroom house is, in fact, a vacant lot. Sometimes (and this also happened to me this weekend), a 3 year old MLS listing does not reveal the fact that a subsequent owner has gutted the property back to the studs, and you’re looking at a shell that needs $45,000 in renovations and will be worth $45,000 fixed up.

But it does help you make some intelligent decisions about where to spend your time, and it’s worth creating your own system for.

P.S. This morning, before I sent this out, I found out that the seller had accepted my $2,200 offer on property “B”, so if anyone is looking for a big rental property on the west side of Cincinnati cheap, give me a call!

Reprinted with permission of Vena Jones-Cox. To get more free articles and tips, subscribe at www.TheRealEstateGoddess.com

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